Personnel Costs Prove Tough to Contain

Pay and Pensions Constitute a Massive Portion of Schools' Costs, but Reining Them in Requires Creativity and Realistic Expectations

Personnel costs—the salaries and benefits that sustain the K-12 workforce—consume an enormous portion of school budgets, and many policymakers are determined to drive those expenses down, even as they also seek to improve academic achievement and the quality of instruction.

Yet reducing those costs is not as simple as chopping away at the state or local education budget, or eliminating programs or services.

State pension systems, which typically cover teachers, generally are protected by state constitutions and other laws, and courts have made it difficult to reduce benefits for current enrollees. And teachers’ salary schedules and health-care costs are often protected by hard-fought collective bargaining agreements at the local level.

There’s a lot of money at stake. The nation’s public schools employ more than 6 million workers, and instructional staff receive about $295 billion in salary and benefits, according to federal estimates. And all told, personnel costs consume about 80 percent of school districts’ budgets, according to the Educational Research Service, an Alexandria, Va., nonprofit that examines K-12 data and policy.

Policy officials and unions have long argued that generous benefits packages are necessary to lure teachers into a profession with relatively modest salaries. But many observers predict that state and local governments will face increasing pressure to cut those benefits in the years to come, as states enter what is likely to be a prolonged period of fiscal austerity.

“The trend over the years was to provide compensation through the relatively hidden cost of retiree health care and pensions,” says Donald J. Boyd, a senior fellow at the Nelson A. Rockefeller Institute of Government, based at the University at Albany, State University of New York, who has examined the recent recession’s impact on government spending. “The chickens are getting ready to come home to roost.”

The economic turmoil has socked states just as many are attempting to move forward with ambitious new personnel models that could have big implications for those entrenched cost centers. A number of states and school districts are implementing or considering performance-based pay and other alternatives to the traditional longevity- and credential-based salary scales.

Yet whether new compensation models—which, in some districts, have required new infusions of cash—can survive in an era of shrunken state and local budgets remains unclear.

“A lot of state agencies and school districts are at a particular point where they barely have the money to cover the basic cost escalators in salaries,” says Raegen T. Miller, the associate director for education research at the Center for American Progress, a Washington think tank. “It seems there wouldn’t be a lot of new money to stimulate the flexibility to implement new compensation reforms. ... It doesn’t mean they can’t. It just means it’s harder, because they’ve got to deal with their existing bread and butter.”

Policy experts say that while there may be many reasons, from an educational standpoint, to change school employees’ salaries and benefits, there’s no guarantee that those steps will produce cost savings. Changes that are popular in some quarters, such as moving to merit pay, may strengthen the workforce, but at a cost.

Others note that making changes to school employees’ retirement benefits—a priority among many state elected officials—is not only challenging legally and politically, but also may not bring immediate savings to states and districts.

Pension Shortfall

The cost of current and future retirees’ pensions and health insurance has become an increasing source of worry among state officials. A report published last year by the Pew Center on the States, titled “The Trillion Dollar Gap,” found that states face a $1 trillion shortfall between what they are obligated to pay current and retired workers—including teachers—in pensions and retiree health-care benefits and the money they have on hand to cover those costs.

States’ pension systems, on the whole, were 84 percent funded, a fairly positive showing, given that most experts recommend an 80 percent funding level, Pew found. Even so, states had a combined $452 billion in unfunded pension obligations, and their individual pension obligations varied greatly. Pew identified four states—Florida, New York, Washington, and Wisconsin—as having fully funded pension systems, as of 2008, the most recent year examined. Yet 21 states, including Colorado, Illinois, and New Jersey, had met less than the 80 percent threshold, according to Pew’s report.

The majority of states’ $1 trillion shortfall came from $587 billion in total liability for retiree health insurance and other nonpension benefits—only $32 billion, or roughly 5 percent of which is funded, according to Pew’s research. States tend to fund retiree health care and other nonpension benefits by paying-as-they-go—covering costs as they are incurred by current retirees; for states that have made significant future promises, “the future fiscal burden will be enormous,” Pew concludes. Moreover, health care costs, and the number of retirees, are growing each year, increasing states’ financial burden, the authors say. Pew’s estimates count retiree health-care and pension liabilities if they belong to the states or to local school systems participating in state-administered plans. They do not include the liabilities that locally run pension and health-care plans might have accrued.

Tackling Teacher Compensation

Personnel costs constitute the single largest
category of expenses in public
education, and teachers make up the
largest group of school employees. In an
effort to manage costs in a time of
shrinking budgets, some states have
moved to enact changes in the rules
governing teacher salaries and benefits.
For example, six of the 20 states with
statewide teacher-salary schedules have
recently enacted changes related to
compensation levels. Although some
recent policy actions are meant to
address immediate economic challenges,
others are intended to help states
manage their longer-term cost
trajectories and fiscal obligations.

SOURCE: EPE Research Center, 2011

The stakes for an individual state can be huge. For instance, the California State Teachers’ Retirement System, known as CalSTRS, has 848,000 enrollees—and roughly $40.5 billion in unfunded liability. California’s entire budget for fiscal 2011, by comparison, is $87.5 billion.

Health insurance for current employees, meanwhile, has long been a concern for states and districts. School employees’ health insurance consumes about 8 percent of all education spending at the combined local, state, and federal levels, estimates Michael Griffith, a senior policy analyst at the Education Commission of the States, a research and policy organization in Denver. Those costs have been rising 10 percent to 15 percent annually, he adds.

Pew’s estimates of pension costs are probably conservative, given that they’re based on data collected before state investments were sapped by Wall Street losses during the downturn, says Stephen C. Fehr, a researcher who worked on the report for the Pew Center on the States, a nonpartisan organization based in Washington.

Despite legal obstacles to reducing benefits for current enrollees, state elected officials have moved to cut costs in a variety of ways, reasoning that their governments simply can’t afford to maintain the current system.

Policymakers recognize that “every dollar that a state has to spend covering unfunded pension obligations can’t be used for education, for public safety, and for other needs a state has,” Fehr says. “It means policymakers have to look at cutting services, raising taxes, borrowing money.”

While the economic downturn may have contributed to states’ pension shortfalls, a larger factor was states’ failure to provide the yearly amounts needed to keep up with pension obligations during both good and bad times, the Pew report says.

Plan Type Matters

More than 80 percent of public school teachers are enrolled in “defined benefit” pension plans, according to the U.S. Bureau of Labor Statistics. In public sector defined benefit plans, employers and employees typically make contributions toward their pensions, and workers are promised a set amount once they reach retirement. Employers, such as states, calculate how much money the plans need and are obligated to cover the promised payouts. The pension amount is based on a formula that typically includes salary, length of service, and a multiplier used to calculate benefits.

Teacher Layoffs

Big Issue, Little State Role
The prolonged economic downturn has
resulted in widespread concern over
the impact that state budget cuts may
have on education jobs. While reductions
in states’ school funding may
ultimately lead to teacher layoffs,
only 12 states play a significant role
in determining whether seniority will
be a criteria for teacher-dismissal decisions.
The remaining states allow local
school officials to choose whether
to use seniority as a basis for teacher
layoffs.

An Information Gap
Detailed information on layoffs could
help policymakers identify and understand
patterns in teacher dismissals.
However, few state education agencies
have collected such data during the
past two years. Among states that do
maintain such records, twice as many
collect data at the district level than for
individual schools.

SOURCE: EPE Research Center, 2011

Most private-sector workers were enrolled in defined-benefit plans a quarter-century ago, but now roughly 80 percent of them belong to “defined contribution” systems, such as 401(k)s, according to the BLS. In those plans, employers contribute a percentage of an employee’s salary to savings, in addition to what workers chip in; workers manage their own investments and bear the risk or the reward, if the market drops or soars.

Many public officials and political candidates interested in cutting costs have proposed switching future employees from defined-benefit to defined-contribution plans. In California’s recent gubernatorial campaign, for example, Republican nominee Meg Whitman, who ultimately lost, called for converting the state retirement system to a 401(k)-style system for new hires, while leaving current enrollees in the defined-benefit plan. Whitman said the pension system was in “crisis” and needed to be aligned with “what most private-sector workers receive.”

Changing pensions for future workers appeals to state officials, partly because it avoids the legal tangles associated with attempting to cut current enrollees’ benefits. When Colorado lawmakers, for example, approved a measure last year to reduce the benefits provided to state and school workers’ pensions, individual retirees sued to block it, arguing that it was unconstitutional and broke a contract. In legal battles, states have argued that not making changes will put their financial systems at risk.

Yet some states, such as Vermont, have managed to make substantial changes to teacher pensions that preserve their core structure, while saving substantial costs.

In a deal worked out between state officials and the 12,000-member Vermont National Education Association, teachers agreed to allow an increase in the retirement age for most educators from 62 to 65, or “the rule of 90,” a combination of teachers’ age and years of service. Teachers also were asked to contribute more to their pensions, 5 percent of salary, up from 3.4 percent.

In return, the cap on teachers’ maximum retirement benefit will rise from 50 percent of average final pay to 60 percent, with an additional increase in the multiplier used to calculate benefits. Retiree health benefits will also be made available to spouses, a provision long sought by the union.

Those changes will result in the state’s costs falling from $63.5 million to $48 million for fiscal 2011.

State Treasurer Jeb Spaulding says he had no desire to let the state become entangled in a court fight. He also says he came to believe that switching new employees from a defined-benefit plan to a 401(k)-style system was the wrong move. Doing so, he says, would have meant keeping current enrollees in the defined-benefit plan, with fewer employees contributing to it, thus taking 10 or 15 years for the state to save money.

“That’s the wrong medicine for the illness we have,” Spaulding says. “It doesn’t save you money at the critical time, which is now.”

Drag on Recruitment?

Teacher pension plans also have drawn criticism in recent years from those who say they do not encourage the recruitment and retention of effective teachers.

Michael Podgursky, a professor of economics at the University of Missouri, in Columbia, and Robert M. Costrell, a professor of education reform and economics at the University of Arkansas at Fayetteville, argue that pension benefits are backloaded and aren’t structured in a way to keep the most effective educators in the classroom.

Teachers accumulate relatively little pension wealth until their early 50s, essentially encouraging them to stay in the profession, regardless of their ability or motivation to stay, the two scholars say. At that point, teachers’ pensions abruptly peak, and then decline, creating an incentive for them to quit, regardless of whether they might have many good years of teaching left, the authors say.

“You’re pulled to a certain point, and then you’re pushed out,” Podgursky says. “This pension system is an enormous lever for retiring your best teachers. ... We’re missing an enormous opportunity. Another system would recognize [the talents] of their people, and keep them on the job.”

Teacher-pension systems also tend to discourage educators’ mobility, Podgursky and Costrell argue. Those systems do so, they contend, by requiring teachers to spend a lengthy period in one system before they become vested, and by not allowing “split-career” teachers, who change pension systems, to accumulate as much for retirement as those who stick it out in one plan, among other features.

The result is a pension system that “may exacerbate the challenge of attracting to teaching young workers, who change jobs and move more often than did previous generations,” Podgursky and Costrell wrote in a 2010 article in the journal Education Next.

Others, like Michael Griffith, of the ECS, disagree, saying that most teachers, when they find schools or districts that appeal to them, base their choices about where they work on factors such as salaries, working conditions, and administrative support. “They tend to like where they teach,” Griffith says. “You can change the retirement system any way you want. They’re not leaving.”

Current teacher-pension plans can be modified in ways that can encourage the recruitment and retention of effective educators, says Bill Raabe, the director of collective bargaining and member advocacy for the 3.2 million-member National Education Association. But he says defined-benefit plans will continue to appeal to future educators for a simple reason: They offer retirement security, insulated from swings in the markets.

Many policymakers also overstate the risks of unfunded liabilities in state pension systems, Raabe argues. While some states will face “difficult decisions” about how to meet future obligations, the vast majority of state pension systems are in solid shape, he says, even after having absorbed heavy losses during the recession.

And Podgursky, while critical of many pension systems, believes much of the defined-benefits-vs.-defined-contributions debate is “extremely polarized and simple-minded.” Like Raabe, he says states and unions can make changes to defined-benefit plans that create the right kinds of incentives, and don’t require switching to a 401(k)-style system.

Podgursky also says states should consider using “cash balance” plans. Typically in those plans, sometimes referred to as hybrids of defined benefit and defined contribution models, employers’ and employees’ contributions, as well as interest, produce a cash balance. The plans often offer a guaranteed benefit, with money being available as either a lump sum or annuity, upon retirement. Supporters say cash balance plans allow savings to accumulate gradually and do not result in incentives that push or pull teachers out of the profession.

Addressing Teacher Pay

While pensions and health-insurance costs have long been a state and district concern, policymakers are paying increased attention to another aspect of personnel costs: changing how teachers are paid. While those efforts are driven primarily by the goal of raising teacher quality and student achievement, some analysts say changing compensation systems has the potential to bring financial savings to districts—even if evidence of those savings so far is limited.

Most states and school districts pay teachers according to a traditional salary schedule, in which pay increases with longevity, as well as with master’s degrees and other credentials. Yet critics question that approach, arguing that there is little evidence that accumulating more years of experience increases teachers’ effectiveness.

For instance, forthcoming research by Stanford University economist Eric A. Hanushek shows that 9.5 percent of teachers’ total salaries is devoted to paying them for obtaining advanced degrees, and that 27 percent goes to paying them for accumulated experience, based on 2008 data, factors that he concludes have not been shown to improve the achievement of students. Conceivably, districts could take that money and redirect it to providing teachers with bonuses based on their performance, he adds. Few districts, however, have taken steps to rework compensation in that way.

Two heavily scrutinized pay-for-performance systems, in Denver and in the District of Columbia, reward teachers for improving student achievement. But both of those systems are supported through extra infusions of cash into the school budgets. Denver’s model, known as ProComp, receives an extra $25 million in yearly property-tax revenue. The nation’s capital last year approved a new contract with its teachers, which was supported with $64.5 million in donations from foundations; about $32 million of that money will support a voluntary pay-for-performance plan, Washington school officials say.

One example of a pay-for-performance plan that is designed to bring no extra costs is that of Colorado’s Harrison School District Two, an 11,000-student system in Colorado Springs. Last fall, the district launched a plan that links teachers’ salaries to their ability to raise student performance, classroom observations, and other factors.

The Harrison district, which has an annual general-fund budget of $80 million, gave about 75 percent of its teachers an initial salary boost at the beginning of the school year when they were placed on the new performance scale for the first time. The district estimates that only about 20 percent of teachers will be given raises based on their performance this academic year, and that the remaining 80 percent will have their salaries frozen, though those numbers could change, Superintendent Mike Miles says.

The Harrison district does not give automatic pay increases, or stipends for advanced degrees. It also does not provide extra pay for teachers’ service as mentors, and it saves considerable money by not paying educators extra to serve as department chairs or team leaders; the district regards those duties as professional responsibilities, Miles says.

The district spent about $1.2 million to create the performance-pay system, with $800,000 coming from a foundation grant, Miles says. But after that initial expense,he believes the system will be revenue-neutral. He also says other districts, including larger ones, could replicate pay models like Harrison’s without incurring new costs, though he thinks the primary motivation for such plans is to recruit new teaching talent and raise student achievement.

Making such changes is popular with the public, which believes that “salaries for teachers should be higher,” Miles argues, “as long as we’re getting results.”

A handful of other school districts, meanwhile, have sought to move away from giving automatic raises to teachers based merely on years of service and degrees held, and toward systems that determine base pay partly according to performance. But those approaches, being tried in Eagle County, Colo., and in Pittsburgh, for example, have not been widely imitated so far, and their applicability in other school systems is unclear.

Shayne Spalten, the chief human-resources officer for the 78,000-student Denver school district, says the financial and contractual constraints that states and districts face don’t necessarily impede their ability to change their pay models.

“The economic climate creates even more of a demand for a performance-based system,” she argues. “The challenge is to tie resources to the goals you’re trying to achieve.”

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